Policing the Border: A History of IRS Regulation of Political Activity

Editors’ Note: Roger Colinvaux continues HistPhil’s forum on anonymous giving with a post that places the controversies over “dark money” contributions into historical and legal context.

The IRS is a partisan political punching bag, perhaps no more so than in the area of regulation of nonprofit organizations. Over the past five years, there have been unrelenting attacks on IRS personnel and its budget – mainly due to the IRS’s fumbled oversight of nonprofit groups. A key flash point is the political activity of nonprofits. When the IRS gets involved in speech-related issues, it is often unfairly cast as a villain, accused of policing the speech of Americans through harassment and intimidation. Rare is the sober assessment of whether the IRS has a responsibility to regulate political activity, the proper scope of the IRS’s role, and the role of Congress. This post is intended to convey the basis for IRS regulation of nonprofit political activity and explain how it has evolved over time.

At the outset, it is useful to recognize that there are two sources of law that regulate political activity. Campaign finance law imposes limits on how much money individuals and entities may contribute to political candidates or political committees, and requires disclosure of campaign donors. These limits restrain speech but have long been justified as constitutionally permitted restrictions that help prevent corruption or the appearance of corruption. Tax law also regulates political activity, which, as explained below, is an inevitable result of the fact that “tax touches everything,” even politics. The fact that there are two legal avenues for regulation of political activity, each with an administrative agency as overseer (the FEC and the IRS), has complicated the IRS’s role because Congress sometimes uses tax law to fulfill campaign finance purposes.

The starting point for understanding the IRS’s tax-based role in regulating political activity is to acknowledge some basic tenets of the federal income tax relating to income and deductions. Income is a term of art, rooted in economic thought, that describes the tax base. Deductions take certain expenses out of the base, meaning that funds used for deductible expenses are tax exempt. As a general rule, no deductions are allowed for personal consumption. Spending on politics, like spending on food, clothing, or movie tickets is considered a personal expense and no deduction is allowed. As a result, the federal income tax includes within its base the cost of political activity. This is not a controversial point, and roughly translates into: If I donate to a candidate or a PAC, or spend money on a political campaign yard sign, I do not get a deduction for the expenses. At this level of personal direct expenditure on politics, there is not much for the IRS to do – political expenses are just like other nondeductible expenses.

The story becomes more complex when Americans exercise their rights of association to form a group. Entities, like individuals, are taxpayers. Thus, a group must have a tax status. Our system recognizes a wide array of tax statuses. For present purposes, there are three main ones: a purely political group, a philanthropic organization, and a mixed political and nonprofit group. (For simplicity, ignore for-profit organizations, which present a separate set of issues.) Each category has a story; and each category requires some IRS oversight.

Consider first the purely political group, which include political action committees (PACs) and SuperPACs. At the outset of the federal income tax in 1913, the extant political groups were political parties and committees. They of course preceded the income tax and arose for functional reasons – to get candidates elected. The question became how the income tax law should treat a political party. Parties collect funds and spend on campaigns. Are political contributions income to the party? Are the campaign expenses deductible? Should the party file a tax return? For years, the IRS did not require purely political organizations to file tax returns because they were viewed essentially as conduit organizations – pooling already taxed dollars for immediate expense. Thus, there was no income to collect at the party level, and the IRS largely ignored these groups from an income tax perspective.

This changed for valid tax reasons. Principally, the IRS came to recognize that political groups might not spend all the money collected, but rather invest the money for a financial return.[1] Applying ordinary tax principles, the investment gains should be subject to tax. Accordingly, the IRS required political organizations to file returns but to pay tax only with respect to investment income. Contributions and expenses could be and were ignored. Thus, political organizations had a sort of administrative-based exempt status: they paid tax only on investment income and were exempt on their contribution income. This tax “exemption” though was not a subsidy, but just an application of the idea that the organization represented a pooling of already taxed dollars, and so should not face a double tax. Congress eventually codified this administrative treatment in 1975.[2] At this stage, the IRS’s role is minimal and appropriate.

The IRS’s role changed in the year 2000, when Congress, seeking to close a campaign finance loophole, imposed disclosure requirements on political groups. By amending the tax code, not the Federal Election Campaign Act, Congress charged the IRS with administering the collection of contributor and expense data and making it publicly available. Henceforth, the IRS became responsible for a campaign finance rule, including the imposition of penalties for nondisclosure. The IRS’s role with respect to political activity thus dramatically increased, but at the explicit direction of Congress.

Next, consider the philanthropic organization, also known colloquially as a charity, or more technically, a group that qualifies under section 501(c)(3) of the tax code. Like political groups, charities preceded the 1913 income tax law, but unlike political groups, Congress thought about charities at the time and decided they should be exempt from the new federal income tax, and further, as of 1917, that contributions to charities should be outside the tax base, i.e., deductible.

Already, a tension is visible. If political activity expenses are not supposed to be deductible, what happens if a charity engages in political activity? Considering that charities are funded with deductible contributions, if a charity is allowed to engage in politics, then the federal government would in effect be providing a tax subsidy for political activity when it is conducted through a charity. Clearly, to preserve the nondeductibility of political expenses, the political activity of charities would have to be limited in some way.

This tension eventually was resolved by legislation. In 1954, Congress amended the tax code to formally prohibit charities from “participating or intervening” in a political campaign. This prohibition on campaign activity was enacted as a Senate floor amendment by then Senator Lyndon Baines Johnson, and is now known as the “Johnson Amendment.” At the time, Johnson faced a tough reelection campaign in which he was attacked by a charity. The amendment was his response, enacted quickly and without explanatory legislative history. The hasty adoption of the prohibition has contributed to a sense that it was little more than a cynical power grab by a skilled legislator, making the rule ripe for reform.

However, this understanding of the prohibition’s history is vastly oversimplified. The circumstances of the amendment’s enactment undoubtedly were opportunistic, but like many pieces of legislation, the idea hardly came out of nowhere. Since the advent of the income tax, it was an open question whether charities could get involved in politics. The common law of charities at the time suggested that political purposes were not consistent with charitable status and that the political and charitable spheres were separate. Early regulations and court decisions on the question ruled that charities should stay out of “political agitation,” under the theory that the government should not subsidize partisan activity through tax exemptions and the charitable deduction. Arguably, the unwritten rule was always that politics (including lobbying activity) and charity were mutually exclusive.

But in a system of taxation that relies heavily on the language of the tax code, unwritten rules often are not enough. Congress first entered the fray in 1934 to restrict (but not ban) “propaganda” activity, but the language used turned out to cover only what came to be known as lobbying, leaving campaign intervention outside the scope of the statute. By 1954, the House of Representatives had held multiple hearings on the political involvement of charities and issued a report calling for the ban of both political and lobbying activity by charities. Thus, LBJ’s proposal was not offered out of the blue but reflected his taking the opportunity to push through a solution to a problem that had been widely debated on Capitol Hill over a long period of time.

Regardless, from 1954 on Congress tasked the IRS with policing a critical border for the charitable sphere – to keep partisan campaign activity out. This oversight role has a tax purpose because it involves preventing the misuse of the charitable deduction. But it is a difficult border to monitor. What is campaign intervention? When does a charity cross the line between advocating on issues and participating in a campaign? Should the IRS revoke tax exempt status for insignificant and unintentional violations as required by the statute? How can the IRS avoid charges of political bias in enforcement? What is the line between permitted personal opinion and institutional political action, especially in the religious context?

The IRS has danced delicately, and sometimes blundered its way through these questions. But all in all, after 64 years of policing the border, the prohibition on political campaign activity has worked and has the broad support of most charities. There are powerful voices of dissent, including that of President Trump and many legislators, resulting in ongoing efforts to weaken or repeal the prohibition. But setting aside the merits of the policy debate, the important point here is to recognize that the political activities prohibition is a rule of tax law, developed over decades, to prevent the subsidy of political campaign activity and the corruption of the charitable sector by partisan voices. The IRS has a legitimate, if difficult, role to play.

The final type of group to engage in political activity is the mixed nonprofit and political group. These have lately become notorious and are often referred to as “dark money” nonprofits. Their story is perhaps the most complex of the three types of groups, in large part because of the political turmoil surrounding their use, as well as murky legal standards and uncertainty about the IRS’s role.

The best way to understand these groups is as nonprofits that do not have a strictly charitable purpose. Like charities, their tax exemption dates to the early days of the income tax. Historically, they included PTAs, neighborhood associations, the local lodge or rotary club, labor unions, and trade associations. Basically, any group that is not organized to make money, but rather to collect and spend money for a generic social purpose can probably qualify, even if members benefit. Unlike charities, contributions to these groups are not deductible as charitable contributions because their purposes, though nonprofit in nature, are not quite public enough. This reduces their importance from a tax oversight perspective.

There are tens of thousands of noncharitable nonprofits, most of them small and designated as “social welfare” groups under section 501(c)(4) of the tax code. Some very large ones exist and are household names, including the NRA, the Sierra Club, the AARP, the ACLU, and the Chamber of Commerce. Many have relationships to charities. For example, the social welfare group Planned Parenthood has a related charitable arm, as do the NRA and the ACLU.

The question of whether these groups may intervene in political campaigns came up in the 1950s, about the same time that Congress passed the prohibition on campaign activity for charities. The Treasury Department decided through the regulatory process that campaign activity by definition did not advance nonprofit purposes (i.e., it was not an activity that was “related” to a valid nonprofit end).[3] Even so, however, nonprofits are permitted to engage in unrelated activities.[4] Thus, the question became how much unrelated activity would be consistent with a group’s tax status. Given that there was no statutory ban on the campaign activity of non-charities, the Treasury Department could not import one by regulation. So, campaign activity was treated just like any other unrelated activity: it was permitted, but it could not be the organization’s primary activity. Thus, from the 1950s onward, campaign or any other unrelated activity was subject to a “primarily” test.

This murky legal standard did not cause many problems until the Citizens United v. FEC decision of the Supreme Court in 2010. Prior to Citizens United, a rule of campaign finance law limited the amount of campaign activity that nonprofits could engage in directly. Thus, even though the “primarily” test was the law, the danger of a group approaching its generous limit for excess political activity was not much of an issue. When Citizens United struck down the campaign finance limit as unconstitutional, however, a new avenue for nonprofit campaign speech opened up. For the first time, nonprofits were free to expressly advocate for or against candidates.

This newfound freedom gave sudden relevance to the “primarily” test of tax law. Because campaign speech could be conducted through noncharitable nonprofits without disclosing donors, all things equal, those preferring anonymity would choose to fund political activity through a social welfare organization or other nonprofit rather than a purely political group, so long as the group did not cross the “primarily” threshold. Accordingly, the moniker “dark money” attached to campaign activity conducted through 501(c)(4) nonprofit groups.

Thus, after Citizens United, the IRS was thrust into the role of actively policing the political activity border for noncharitable nonprofit groups, scores of which suddenly formed. This border though is harder to police than that in the charitable context because it involves not only determining what constitutes prohibited activity, which is based on the facts and circumstances, but also how much activity exceeds the “primarily” threshold. The IRS’s mismanagement of the issue led to intense (and unfair) attacks on the agency, including calls for impeachment of the IRS Commissioner.

Setting aside the merits of this dispute, however, the critical point here is that there is a non-tax based incentive to conduct political activity in noncharitable nonprofits (nondisclosure of donors), which again places the IRS into a campaign finance regulatory role.[5] Ironically, the IRS’s subsequent efforts to adapt the rules of the 1950s to a post-Citizens United reality were stillborn, when Congress ordered the IRS to cease writing regulations on the topic. Thus, Congress has essentially frozen an untenable status quo in place, thereby implicitly embracing the deliberate use of nonprofits for significant anonymous political spending and happily allowing the IRS to carry on the precarious role of adjudicating amorphous political activity limits.

By way of summary, the IRS has a role in regulating political activity for three different types of groups. For charities, the IRS performs a vital oversight function, necessary to protect the tax base and the integrity of the charitable sphere. For political and noncharitable nonprofit groups, the IRS has a mixed mission. On the one hand, the IRS has a modest, non-controversial, revenue-related function (to collect tax on investment income). On the other hand, the IRS is responsible for administering the campaign finance disclosure rules for political groups and, at the same time, limiting the flow of dark money to noncharitable nonprofits through enforcement of a vague test Congress has ordered the IRS not to fix.

So what does it all mean? IRS regulation of political activity is a source of confusion, misinformation, and controversy. In order to evaluate arguments about the IRS’s oversight in this area, it is important to understand the narratives outlined above. More broadly, because of the damage caused by the vitriol and opportunistic behavior of the last several years on this issue, a key goal of policymakers should be to limit IRS involvement in regulating political activity to areas where there is an important tax objective. As I havewrittenextensivelyelsewhere, this means retaining the prohibition on campaign intervention for charities, making the disclosure rules consistent across tax-exempt groups, and then, to minimize unnecessary oversight, removing limits on the political activity of noncharitable nonprofits to update the law to reflect the realities of the post-Citizens United era.

-Roger Colinvaux

Roger Colinvaux is a Professor of Law and Director of the Law and Public Policy Program at the Columbus School of Law, The Catholic University of America. From 2001-2008, Professor Colinvaux was Legislation Counsel at the nonpartisan Joint Committee on Taxation in the U.S. Congress, with responsibility for tax legislation relating to nonprofit organizations.

NOTES:

[1]Another tax reason related to the gift tax, a complicating factor not discussed here. There were also political considerations, relating to the tax treatment of the Communist Party (which resulted in litigation).

[3]As I have argued elsewhere, this decision is debatable, especially now. There is no obvious tax-based reason to limit the political activity of non-charitable nonprofits.

[4]Congress made this explicit in 1950 when it enacted a tax on the “unrelated business income” of charities and other nonprofits. By taxing commercial activity, Congress implicitly recognized that nonprofits were allowed to engage in significant amounts of “unrelated” activity consistent with their underlying tax status, notwithstanding that the statute says that charities and many other nonprofits must be operated “exclusively” for their nonprofit purpose.

[5]Congress in 1975 appropriately charged the IRS with enforcing a tax based on the investment income of nonprofits that engage in campaign intervention. The tax is intended to make sure that political activity is taxed consistently between purely political groups and other nonprofits.